Focus on Ethics box described some of the consequences of the accident at BP’s Deepwater H...

Focus on Ethics box described some of the consequences of the accident at BP’s Deepwater Horizon oil rig. The company put up $20 billion to help pay for damages related to the oil spill, yet BP’s market value declined by more than $90 billion. That means that the market assessed BP an additional penalty of roughly $70 billion, above and beyond the direct costs associated with the spill. Describe the effects that an increase in BP’s cost of capital could have on the market value of BP. Oil spills have happened before, so it is plausible that engineers and analysts at BP could have imagined a worst-case scenario in which a major spill occurred at one of the firm’s offshore rigs. How might a thorough scenario analysis have influenced BP’s offshore drilling activities?

BP

Worst Case Scenario

On April 20, 2010, an explosion destroyed BP’s Deepwater Horizon offshore oil rig, resulting in the largest oil spill in U.S. history. As much as 2.5 million gallons of oil spewed into the Gulf of Mexico each day, eventually reaching the shoreline in several states and causing serious harm to the environment. Under pressure from the Obama administration, BP agreed to establish a $20 billion fund to pay for spillrelated expenses such as clean-up costs and compensation for lost income for individuals and businesses directly harmed by the accident.

When managers undertake large investments, they often invest a tremendous amount of time and money trying to understand the risks associated with these investments. In the case of BP, an accident at a rig that cost $500 million to build cost the company more than $20 billion. As news of the accident and subsequent spill evolved, BP’s stock price plunged, falling from $60 to less than $30 in just 7 weeks, wiping out more than $90 billion of the firm’s market capitalization.

This chapter focuses on the tools available to managers that help them better understand the risks of major investments.